Comprehensive Guide

IRA Plans

Introduction

An Individual Retirement Account (IRA) is a tax-advantaged savings plan that individuals can use to save and invest for retirement. Unlike a 401(k), which is sponsored by an employer, you can open an IRA on your own through a financial institution.

Basics of an IRA

Individual Account: As the name suggests, an IRA is set up by an individual, not through an employer.

  1. Tax Advantages: The primary benefit of an IRA is its tax treatment, which can be either tax-deferred or tax-free, depending on the type of IRA.

  2. Contribution Limits: The IRS sets annual limits on how much you can contribute to an IRA. These limits can change each year.

  3. Flexibility: You have more control over where your money is held and the types of investments you can make within an IRA compared to a 401(k).

Types of IRAs

There are two main types of traditional IRAs:

  • Traditional IRA:

    • Contributions: May be tax-deductible, depending on your income and whether you are also covered by a retirement plan at work. If deductible, this lowers your taxable income in the year you contribute.

    • Growth: Investment earnings grow tax-deferred.

    • Withdrawals: Distributions in retirement are taxed as ordinary income.

    • Eligibility: Generally, anyone under age 75 with earned income can contribute to a traditional IRA.

  • Roth IRA:

    • Contributions: Are made on an after-tax basis, meaning your contributions are not tax-deductible.

    • Growth: Investment earnings grow tax-free.

    • Withdrawals: Qualified withdrawals in retirement (after age 59½ and having the account for at least five years) are tax-free.

    • Eligibility: Your ability to contribute directly to a Roth IRA is subject to income limitations. These limits change annually.

There are also other types of IRAs designed for specific situations:

  • SEP IRA (Simplified Employee Pension Plan): Typically used by self-employed individuals and small business owners. Employers (including themselves) can contribute to their own SEP IRA and their employees' SEP IRAs. Contributions are tax-deductible, and earnings grow tax-deferred.

  • SIMPLE IRA (Savings Incentive Match Plan for Employees): Another retirement plan for small businesses and self-employed individuals. Employees can choose to make salary reduction contributions, and employers are required to either match employee contributions or make non-elective contributions. Contributions are tax-deferred.

  • Rollover IRA: Used to hold funds that have been rolled over from another retirement account, such as a 401(k) or another IRA. This allows the money to continue growing tax-deferred or tax-free.

Contribution Limits for 2025

The IRS sets annual limits on how much you can contribute to a traditional or Roth IRA. For 2025, these limits are:

  • Regular Contribution Limit (under age 50): $7,000

  • Catch-Up Contribution Limit (age 50 and over): An additional $1,000, making the total for those 50 and over $8,000.

These limits apply to the total contributions you make to all of your traditional and Roth IRAs combined.

Tax Advantages

  • Tax Deduction (Traditional IRA): If your contributions to a traditional IRA are tax-deductible, you can lower your taxable income in the year you make the contribution. This can result in immediate tax savings.

  • Tax-Deferred Growth (Traditional and Roth IRA): Your investments within both types of IRAs grow without being taxed until withdrawal (in the case of a traditional IRA) or are never taxed upon qualified withdrawal (in the case of a Roth IRA). This allows your money to compound faster.

  • Tax-Free Growth and Withdrawals (Roth IRA): The primary advantage of a Roth IRA is that if you meet the requirements for a qualified withdrawal in retirement, both your contributions and earnings are completely tax-free. This can be particularly beneficial if you anticipate being in a higher tax bracket in retirement.

Investment Options

IRAs offer a wide range of investment options, typically including:

  • Stocks: Shares of ownership in publicly traded companies.

  • Bonds: Debt instruments issued by corporations or governments.

  • Mutual Funds: Professionally managed portfolios of stocks, bonds, or other securities.

  • Exchange-Traded Funds (ETFs): Similar to mutual funds but trade like stocks on an exchange.

  • Certificates of Deposit (CDs): Savings accounts with a fixed interest rate for a specific period.

  • Money Market Accounts: Low-risk, liquid accounts that pay interest.

  • Real Estate: In some cases, you can hold real estate within an IRA, although this is more complex and usually involves a self-directed IRA.

You have the flexibility to choose investments that align with your risk tolerance and financial goals.

Withdrawals

  • Traditional IRA:

    • Early Withdrawals: Withdrawals before age 59½ are generally subject to a 10% early withdrawal penalty in addition to regular income taxes.

    • Withdrawals in Retirement: Distributions are taxed as ordinary income.

    • Required Minimum Distributions (RMDs): You generally must start taking RMDs from a traditional IRA at age 73 (increasing to 75 in 2032).

  • Roth IRA:

    • Early Withdrawals: Contributions can be withdrawn tax-free and penalty-free at any time. However, earnings withdrawn before age 59½ and before the account has been open for five years may be subject to taxes and a 10% penalty.  

    • Qualified Withdrawals in Retirement: Withdrawals of both contributions and earnings are tax-free if you are at least 59½ years old and the account has been open for at least five years.

    • No RMDs During Owner's Lifetime: Unlike traditional IRAs, you are not required to take distributions from a Roth IRA during your lifetime.

Rollovers and Transfers

You can move money between different types of retirement accounts without triggering taxes or penalties through rollovers and transfers:

  • Rollover: You receive a distribution from one retirement account and then reinvest it into another within a certain timeframe (typically 60 days).

  • Direct Transfer: Funds are moved directly from one retirement account to another without you taking possession of the money.

Common rollover scenarios include moving funds from a 401(k) to a traditional or Roth IRA when you leave an employer, or converting a traditional IRA to a Roth IRA.

Key Considerations

  • Eligibility and Income Limits: Be aware of the income limitations for contributing directly to a Roth IRA and the rules regarding the deductibility of traditional IRA contributions.

  • Contribution Timing: Contributions for a given tax year can typically be made until the tax filing deadline of the following year (e.g., April 15th, unless extended).

  • Investment Strategy: Choose investments that align with your long-term goals and risk tolerance. Consider diversification to help manage risk.

  • Fees: Be aware of any fees associated with your IRA, such as account maintenance fees or investment management fees.

  • Coordination with Other Retirement Plans: If you also participate in a 401(k) or other employer-sponsored plan, understand how this might affect your ability to deduct traditional IRA contributions.

Summary

IRAs offer a valuable way for individuals to save for retirement with significant tax advantages and greater control over their investments compared to employer-sponsored plans. Understanding the different types and rules can help you choose the best option for your financial situation and secure your future.